VCs Went to the Cloud in 2010

Forget social gaming and social media. You can even dismiss the iPad, mobile apps, Facebook and Apple altogether.

In looking back over what the key VC story was in 2010, it has to be defined as the year of the cloud.

All you have to do is take a look at how the cloud has gone mainstream, with the Microsoft TV commercial that shows a couple in an airport trying to cure their layover boredom. They then cheer, “To the Cloud.”

To the cloud, investors and acquirers have gone. The cloud is more than just a silly pop-culture reference. It is a new acquisition target. Witness the recent acquisition of Isilon Systems (for $225 billion by EMC), the bidding war that erupted over 3PAR (Hewlett-Packard bought it for $2.4 billion) and the purchase of Compellent Technologies Inc. (by Dell for $820 million).

In addition, CA Technologies, IBM, VMware and Citrix Systems have all bought cloud-related tech companies this year that were VC-backed, as Amazon and other providers are boosting their cloud services. Microsoft, with its TV campaign, is clearly interested in achieving some sort of cloud dominance.

Meanwhile, numerous cloud startups raked in significant funding rounds this year. In 2010, a total of 68 cloud-related, U.S.-based companies raised more than $500 million in funding, according to preliminary data from Thomson Reuters (publisher of VCJ). What’s more, much of the cloud funding activity happened in the last half of 2010. From July 1 through mid-December, 41 cloud companies (or more than half of the year’s total) raised $285 million in funding. In comparison, throughout 2009, just 49 companies with cloud in its description raised about $230 million in funding.

Just last month, Clustrix, founded by Paul Mikesell—one of the co-founders of Isilon—raised $12 million in a Series B round from U.S. Venture Partners, Sequoia Capital and ATA Ventures, bringing its total funding to $30 million.

The question, then, is will enthusiasm remain upbeat in 2011 for all things cloud? Jake Sorofman, chief marketing officer at rPath, thinks so. “We’ll see cloud driving a transformation in the cost and responsiveness of IT service delivery,” he says.

It all adds up to 2010 being the year of the cloud.

Large Enterprise Leads the Charge

Globalization and a push by corporations large and small to reduce IT costs has brought more attention to cloud computing as a more cost-effective IT outsourcing model, especially for the enterprise.

As a result, major cloud-related vendors, such as Amazon, CA Technologies, Citrix, Oracle, SAP, Microsoft and VMware, are doing battle over market share in the cloud sector. And VC-backed startups are following the trail, as well.

“A lot of enterprises are trying to figure out their cloud strategy, and they’re trying to figure out what’s the best thing for them to do to save money,” says Bernard Dallé, a partner at Index Ventures, which counts cloud companies Cloud.com, Gluster and OpTier in its portfolio. “As IT spending increases across corporations, I expect next year and 2012 will be big for cloud startups.”

“All these startups and other VCs are seeing the same thing that we are—the cloud is a hot sector as customers are trying to take advantage of the technology,” Dallé says.

As Dallé and other GPs point out, cloud investing is up in 2010 as more and more startups target the enterprise, where large corporations, from General Electric to travel company Sabre Holdings, are beginning to invest in their IT strategy.

The reason is simple. Cloud computing, and private clouds, in particular, are remaking the data center, and over the next several years expect to change the nature of corporate computing. Clouds offer new economies of scale by creating big pools of servers and storage that can be shifted on demand from one workload to the next.

The benefits add up. Pooling and virtualization allow IT to be delivered as a service, similar to the online approach of Google Apps. This provides the flexibility to quickly roll out new applications, offers greater self service to business units and lets IT managers track an individual department’s IT use.

Milpitas, Calif.-based Aryaka Networks, which emerged from stealth in September following a $14 million Series A round from Mohr Davidow Ventures (MDV), Trinity Ventures, Nexus Venture Partners and Stanford University, is one example of a cloud startup working to improve network connections.

Aryaka CEO Ajit Gupta says that increased globalization is helping to push the emergence of so much cloud-related activity, especially in the storage sector. “With globalization comes increased IT budgets and a more complex computer system to manage,” he says. “Corporate IT departments want things to be simple and easy-to-use, which is why there’s a need for a WAN optimization like ours.”

But it will take time for enterprises to transforms their IT operations to the cloud. The market is in an early stage, with many corporations just now beginning to experiment with cloud pilots running less important applications and drawing in small groups of IT workers.

“There is a shift in how technology is being absorbed in the enterprise,” says Rob Chaplinsky, managing director at Bridgescale Ventures, where he focuses on cloud computing and virtualization. “The old guard [the large cloud-related vendors] is being challenged.”

Another firm that is focused on cloud deals is Redpoint Ventures, which earlier this year raised a $400 million early stage fund that named cloud computing as one of its three main focus areas, in addition to mobile an cleantech deals.

Satish Dharmaraj, a partner at Redpoint and who focuses on cloud computing, says that one area the firm is looking at is taking applications that used to run behind firewall and moving them to the cloud. He says this is a big trend for small and mid-sized businesses (SMBs).

“SMBs are enjoying this trend now because they don’t have large IT departments already in place,” Dharmaraj told the online news site ReadWriteWeb last year.

Another focus area for Redpoint is where large enterprises have data centers that are becoming a private cloud, and running vendor software on your own infrastructure that has been packaged for virtualization footprint.

Among Redpoint’s active enterprise software cloud-related portfolio companies are Azul Systems, Cloud.com and StorSimple.

Jim Smith, a partner at MDV, which backed Aryaka, says that many of the early stage rounds over the past six months reflect the new push of corporations to build up their cloud infrastructure. Still, “we’re at the beginning,” Smith says. It has not turned mainstream yet.

All these startups and other VCs are seeing the same thing that we are—the cloud is a hot sector as customers are trying to take advantage of the technology.

Vineet JainCEOEgnyte

“In 40 years in the business, I’ve never seen such a vibrant startup environment,” Patricof told Reuters last month.

He added that, in spite of the global financial crisis of the last two years, “there’s a lot of money around and there’s an enormous increase in startup activity.”

That is largely due to the practice of cloud computing—running computer programs from remote servers. This has eliminated many of the costs involved.

“Ten years ago you would have needed a lot more money to start a company,” Patricof said. “Cloud computing eliminates capital expenditure so you can go global very quickly—you don’t have to have extensive servers in every country.”

Mark Boslet contributed to this article.

EXECUTIVE PERSPECTIVE

Many More Companies Will Take Advantage of the Cloud

By Darron Antill, COO, AppSense

Enterprises are intrigued by the potential benefits of the cloud, as they should be. After all, greater ROI, reduced cost and increased flexibility will never go out of style.

However, despite their interest, many businesses have spent 2010 sitting by the side of the pool, watching and waiting to see whether the companies that have already deployed clouds would sink or swim. A few dipped a toe in the water, testing their own small clouds, while some braver ones dove in completely. In fact, this is a key advantage of cloud services. One does not have to jump in with both feet. Migrations can be made one service at a time, as appropriate to the enterprise.

In 2011, undoubtedly many more companies will follow suit after witnessing how much fun their compatriots are having in reaping the benefits of the cloud. As cloud computing moves from the lab to actual deployments in the new year, enterprises also will realize how the cloud can help them get more from their application and desktop virtualization technologies, which is one reason VCs and investors have been so bullish about the cloud’s potential.

2011 is when the cloud will enter its deployment phase and companies will begin building their own private clouds to reduce cost and increase flexibility. Some enterprises may choose to migrate all of their desktops and applications to the cloud, while others may prefer to keep their data close and use the cloud only for particular application services.

One thing is certain—regardless of whether the enterprise IT environment is physical, virtual or in the cloud, the user will remain crucial. Without support from end users, deployments will be destined to fail or at the very least will experience significant time and efficiency delays.

This upcoming year will be important in the evolution and widespread adoption of cloud computing, which will require a strong focus on how to manage the user in the cloud.

EXECUTIVE PERSPECTIVE

Cloud Predictions for 2011

By Jeff Ready, Founder and CEO, Scale Computing

1. Look for networking and server companies, such as Cisco Systems and Juniper Networks, to make the move to storage. After all that’s where the money is. This move may come via strategic partnerships or acquisitions. Either way, they’ll be there.

2. Unified and scale-out storage companies will experience rapid growth in 2011, compared to block storage. According to IDC, block storage is growing at a rate of 4% per year while unified storage and scale-out storage are growing at about 15% per year. While block storage is currently the bigger piece of the puzzle, the world is shifting towards unified and scale-out storage and as that shift occurs, demand for these products will increase.

3. Expect acquisition activity within the storage industry to continue through 2011 (and the years to come). That said, these acquisitions will be smaller than 2010’s whoppers (3PAR, Isilon and Compellent).

4. The storage industry will see the most growth in the SME/SMB space. Expect to see SME growth 3x to 4x that of the enterprise in 2011. With that growth, the industry will experience demand for storage products that are simplified and easy to use to cater to the demands of the SME.

EXECUTIVE PERSPECTIVE

2011 Forecast: The Cloud Will Catalyze More IT Transformations

By Jake Sorofman, Chief Marketing Officer, rPath Inc.

From a venture investment perspective, 2010 was certainly the year of the cloud.

Cloud was both the basis for new product innovation and the foundation for new capital-efficient business models enabled by enterprise-class infrastructure on-demand.

For startups, cloud has been transformational, acting as the catalyst for launching and scaling compute-intensive services that would have otherwise been rendered cost-prohibitive. But cloud is also coming into its own for enterprise IT. In 2011, we’ll see cloud transform the cost and responsiveness of IT service delivery.

Venture investments will follow this same theme as innovators are drawn to the enterprise cloud opportunity.

I see three important themes on the horizon:

Private Cloud Proliferates

The second half of 2010 was all about private cloud. The rise of Amazon EC2 brought new clarity and focus for CIOs, who recognized that without a transformation in its delivery models, IT would be disrupted by the speed, flexibility and economy of public cloud services.

In 2010, we saw venture investment validate this premise with high profile bets on Eucalyptus, Nimbula, Cloud.com, rPath, among other enablers of private cloud computing. In 2011, we’ll see widespread enterprise investment in private cloud projects and, continued VC attraction to this investment theme.

Controlling the Cloud

At the same time, we’ll see explosive growth in public cloud services. We’ll also see more evidence of rogue enterprise workloads leaking to the public cloud outside of the reach of corporate policies. This will motivate IT leadership to define governance models for controlling cloud.

Ten years ago you would have needed a lot more money to start a company. Cloud computing eliminates capital expenditure so you can go global very quickly—you don’t have to have extensive servers in every country.”

Alan PatricofFounder and Managing DirectorGreycroft Partners

The need to govern cloud workloads will drive interest in next-generation monitoring, CloudKick, lifecycle management, rPath, and security tools, Ping Identity, as key investment themes.

Hybrid Cloud

Enterprise IT will experiment with hybrid cloud models. Initially, this will look like a simple stratification of deployment environments based on lifecycle stage.

But such experimentation will enable IT leaders to define the reference architecture for the dynamic data center of the future, where workloads can move fluidly between deployment environments based on optimizations for price, policy and performance. As workloads are decoupled from infrastructure, the role of the CIO can evolve from operationally focused to sourcing and portfolio focused, as a competitive marketplace of cloud service providers emerges.

This vision will drive interest in innovations that enable application portability, next-generation IT financial management and decision support tools for dynamic optimizations; and, ultimately, reverse auction tools that analyze and act on dynamic capacity trading decisions.

Whether you’re prepared to bet on these particular themes, one thing is worth taking to the bank: Enterprise cloud has arrived.

EXECUTIVE PERSPECTIVE

More Storage Exits to Come, but Don’t Discount Software

By Mark Davis, CEO and co-founder, Virsto Software

Storage sure looks sexy to venture investors these days. The acquisitions of 3PAR, Compellent and Isilon Systems add up to more than $5.5 billion. All three were storage hardware companies of the same vintage, about a decade old, and big wins for their VC investors.

Looks like virtualization and cloud storage are the places to invest, no? Well, I sure think so, and placed a huge personal bet three years ago by starting a company precisely aimed at these markets.

What’s interesting to note is that all three deals were partially justified by acquirers, financial analysts and pundits as plays in the new virtualized, cloud data center. Yet the core technologies touted to justify lofty valuations were developed before the emergence of virtualization, let alone cloud computing.

When they were founded, none of these three storage companies were designing for a world of virtualized clouds. None of them redesigned their products from the ground up for these new markets. They did change their marketing messages, to be sure. With this repositioning, they achieved cachet, and I cheer for their successfully grabbing the brass ring.

As a venture investor, the question is what storage plays will pay off five to 10 years hence, when virtualization and cloud become mainstream?

Will the new owners of 3PAR, Compellent and Isilon take all of the market, in which case new startups need not apply? History and technology trends suggest not.

There are plenty of technical obstacles yet to be solved in this space. Proprietary hardware systems architected 10 years ago, now captured by giants who inherently aren’t as innovative as startups, aren’t likely to be the ultimate answers.

One thing is certain: cloud computing and virtualization are fundamentally different. It is clear that new approaches to storage are going to be game changers in enterprise and cloud virtual computing.

It’s a very good bet that the big winners a few years from now will emerge from a whole new generation of startups.

There will surely be more significant storage exits as the cloud and virtualization markets develop. What is not so obvious is that they will be proprietary hardware plays.

In the computer business, value has migrated from hardware to software. Storage has lagged in this regard by a decade or so, but the transition is tangible. That’s why my bet in the next generation storage market is on software.

EXECUTIVE PERSPECTIVE

It’s All About the Cloud

By Sheng Liang, Founder and CEO, Cloud.com

2010 has been an incredible year if you were an investor or a company executive focused on cloud computing.

While there has been an ongoing fray about what is and what isn’t a cloud, a few things remained constant over the past year: VCs were investing, classic IT vendors were busy acquiring and customers were listening.

Investments

It was raining money in 2010 if you were a cloud startup searching for funding. Hundreds of millions of dollars were forked over by VCs hungry to find the next big thing and wary of falling behind. Leading VC firms such as Index Ventures and Redpoint Ventures created a cloud computing practice to ensure they were on top of the market, and have clearly made some very strategic investments in cloud computing leaders.

On the receiving end of these investments were cloud companies like RightScale, StorSimple, Cloud.com, Eucalyptus, Nimbula and other cloud infrastructure players. Just scratching the surface, these five players alone pulled in about $100 million in investments in the last 12 months.

Acquisitions

As legacy vendors found it difficult to build out their cloud portfolios, they figured “if you can’t beat them, buy them.”

The year started off with aggressive moves by CA and IBM, picking up infrastructure software and services firms. Platform as a Service (PaaS) was a hot technology segment, clearly seen with the acquisitions of Heroku and Makara. As drivers of the developer experience, these pieces have become critical components of the new cloud ecosystem. Cloud storage took off also during the year with three monster acquisitions of 3PAR, Compellent and Isilon Systems by big hardware vendors. Most surprising to me in all of these were the multiples paid out to the players, some bordering on 50x to 100x of revenue.

While 2010 was a record year for cloud computing, it was just a precursor to what we can expect to see over the next few years. Most analysts agree 2010 was about enterprises learning about the cloud, and 2011 will be about deployment.

Given this, I am predicting VC investments and acquisitions will be in full force in 2011, as well.